Just sort of randomly thought about UK retirements and wondered about their equivalent to 401k, so looked it up. I saw these were created in the late 1980s. I know state and occupational pensions are much older, of course. But where there any invest-what-amount-you-like-up-to-certain-limit tax deferred defined contribution account earlier than these? Or did those who wanted to invest more for a more comfortable retirement just use taxable brokerage accounts?
I don’t believe there were. I think the assumption was that if you were employed, you had a pension (through your employer), if you were self employed you were on your own when it came to retirement savings. Until the personal pension came in, in 1988. I think the Retirement Annuity Contract may have pre-dated this, but not sure. If it did, it wasn’t by that many years. I guess the thought was that if you were self employed, you sold your business when you retired and that have you enough money to live on. Good in theory, not always in practice.
Thanks for the information.
The retirement annuity contract was introduced in the UK in 1956, and (my speculation) may have replaced some earlier arrangement offering tax deferment for retirement savings. Simple considerations of equity suggest that the self-employed, and those in non-pensionable employment, should have had access to some form of tax deferred arrangement to facilitate/encourage retirement savings, since those in pensionable employment had such access. I think if nothing had been available it would have been a matter of controversy and dissatisfaction.
As for workers in pensionable employment, around 1985 it became mandatory for all occupational pension schemes to allow members to pay additional voluntary contributions in order to secure extra retirement benefits (usually but not necessarily calculated on a defined contributions basis). Prior to that schemes were permitted but not required to allow members to pay AVCs, and AVCs were tax-deferred. I think that contributions to occupational superannuation funds, including AVCs, have been tax-deferred in the UK since 1921.
Thank you. AVC was at term I had not come across. Hardest part about searching for something you are unfamiliar with to me is that you don’t know terms you need to find information on it because you are unfamiliar with them so it’s a bit of chicken-and-egg thing. At least for me.
Just to add what “tax deferred” means here.
Contributions to a pension fund are tax-exempt, which means that when people and their employers pay into a pension, the contributions are exempt from taxation. Both the saver and any contributing employer receive tax relief, up to set limits. Also, if the pension savings grow through investments, this is exempt from taxation.
The standard tax rate is currently 20% so the exemption effectively adds that to the pension pot.
When pensions are paid out, the payments are taxed as income. The Sate Pension is lower than the threshold for income tax, but it gets added to any additional pensions to calculate the total tax due.
Thanks for the correction - I (clearly) had no idea they dated back that far.
“Tax-deferred” is a common shorthand for the combination of (a) tax exemption for contributions to pension funds, plus (b) tax liablity for payments from pension funds.
The thinking is that you have earned the amount contributed to a pension fund by you or on your behalf — it’s part of the earnings from your employment — so the default is that it should be subject to income tax as earned income. But you get an exemption, the quid pro quo being that, when the accumulated value of the pension fund is paid out to you, it is taxed as income. So tax on this element of your earned income isn’t avoided; it’s just deferred until the earned income is paid to you. Hence, tax-deferred.
You ar right of course. It’s just a different way of looking at it and tax here is mostly by PAYE so we tend to think differently about it.
Pension payments are taxed by PAYE, just like wages and salaries are.
They are but there is a complication. There is no facility to deduct tax from the State Pension, so HMRC adds it to a private pension if you have one and take all the tax from that. It makes it look as if the private pension is worse than it is.
Additionally, any dividends outside an ISA after the £1000 allowance are taxed at 8.75% for basic rate taxpayers.